For LP investors: what does your sponsor diligence process actually look like?

[Matt Gluckman]

I’ve been spending more time looking at the LP side of real estate syndications seeing a pattern:

A lot of diligence still seems to come down to:

• -referrals
• -prior relationships
• -reputation within a relatively small network

Which works until you’re trying to evaluate someone outside of that circle.

Where I’m struggling to get clarity is on how LPs are validating things like:

• -a sponsor’s full track record across deals
• -how they’ve handled deals that didn’t go to plan
• -what the LP experience actually looked like after closing (communication, transparency, etc.)

So I’m curious how people here are approaching it in practice:

• -What does your diligence process actually look like before you wire capital?
• -What are your non negotiables?
• -Are there specific questions or data points you’ve found most revealing?
• -For those who’ve had a deal go sideways, what did you miss upfront?

Not looking for theory as much as real world process and lessons learned.

My working hypothesis is that this part of the market is still heavily relationship driven, without much shared visibility from the LP side but I’m open to being wrong.

[Evan Polaski]

@Matt Gluckman, my first stop is always LinkedIn for the founder's true experience, both at their company and in the industry as a whole.  

To validate the company's track record, I would be comparing various data sources. Company deck and website, combined with google searches for ("company name" acquisition), etc.

But where my diligence comes in starts with sponsor's real experience in that asset class.  If their name isn't BlackRock or their AUM isn't north of $5bn, and they market themselves as "operators" they have no business being in multiple asset classes.  

Then, I look at projected returns. Not for the actual numbers, but if they are marketing gross or net returns, and if they seem reasonable for that business plan. I.e. a value-add multifamily projecting a 20%+ net IRR while being acquired at a 5% cap rate, is not realistic in my opinion.

Then I look at their fee strucure.  If they are charging more than a 2% acquisition fee, I do not continue anymore.  They are in the business of acquiring assets for fees, not finding the best deals.

And then, if I decide to setup a call, I will ask for a few of their currently owned asset income statements and the initial packages sent for those deals. I want to see how their assets are performing today compared to initial projections. Are they 40% under projections on NOI across the board?

Lastly, I try to talk to a lot of syndicators.  I have some set questions I ask all, and then also let the conversation take shape naturally.  While this isn't the most quantitative way of due diligence, you would be surprised with how many founders and/or their reps don't have answers to basics like: how do you treat your distributions on your K-1 or will you be filing a composite return in that state?  Let alone: what happens when you have to hold longer than 5 yrs, and your capex budget is reliant on getting out before the roof needs replaced or the property needs replaced?